Car finance: everything you need to know

When the time comes to buy a car, whether it’s brand new or second-hand, many of us need a helping hand with the cost.

According to data from the Finance & Leasing Association, around 960,000 new cars were bought on finance in 2018, with a further 1.5m used cars purchased with the help of some form of car loan.

However, there are a few different options when it comes to car finance, so it’s crucial that you understand exactly what you are signing up for in advance.

Hire purchase

With hire purchase, you are essentially taking out a loan which is secured against the car itself.

You’ll have to pay an initial deposit, and then follow that with a set number of monthly payments in order to clear the balance of the loan.

You don’t actually own the car until you make the final payment. As a result, you can’t sell the vehicle without the lender’s permission, while the car can be repossessed if you don’t keep up with your repayments.

You can generally arrange these with the car dealer, so it should be nice and simple to sort out.

Personal contract purchase (PCP)

The process with a PCP deal is, on the face of it, rather similar to a hire purchase arrangement.

Once again there is a deposit followed by monthly payments over a set period, but these payments are likely to be much smaller than with a hire purchase deal. When you come to the end of the repayment period, you won’t have paid enough to take outright ownership of the vehicle.

You’ll then have the option of paying what’s called a ‘balloon payment’ in order to own the car outright. You can instead choose to return the vehicle at this point, or sell it on in order to pay off that balloon payment.

You and the lender will need to agree on a mileage limit - this limit then plays a part in them working out what the car is likely to be worth at the end of the payment period, and therefore what size balloon payment you’ll need to make in order to keep the car.

This mileage limit is really important - if you exceed it you may be hit with financial penalties, making it even more expensive if you plan to keep the motor. Further penalties will apply if the car picks up more wear and tear than is expected, like scratches and bumps.

PCP deals particularly suit people that want to change their car every couple of years, but these deals can work out as seriously expensive.

The great car finance swindle?

According to the regulator, the Financial Conduct Authority, there are some real challenges with these areas of the car finance market. It found “widespread use” of commission systems where the car dealer or credit broker is able to set the borrower’s interest rate, and link the commission they earn to that rate of interest.

As a result, they can put the borrower on a more expensive deal in order to pocket a bigger slice of commission. The regulator reckons that some car finance borrowers have ended up paying more than £1,000 in extra interest charges as a result of being shunted onto expensive deals, costing consumers as much as £300m a year overall.

The regulator said it was also concerned that firms weren’t being transparent enough about the contracts borrowers were signing, nor rigorous enough in checking the loans were actually affordable.

While the regulator has pledged to take action, it’s really important that you read the contract very closely before signing up to any hire purchase or PCP deal so that you understand not only how much you are going to have to pay, but also what sort of perk the dealer or broker is getting as a result of finding you that deal.

Personal loan

The final form of car finance many people consider is a personal loan. This is a relatively straightforward way to borrow - the loan isn’t secured against an asset, like the car, and you repay it over a set period with fixed monthly repayments.

Importantly, you will own the car from the moment you get the keys, meaning you can sell it whenever you like, even if you haven’t paid the loan off yet.

There won’t be a deposit to pay, though the interest rate may be higher than you’ll get with the other forms of borrowing above. You won’t have to arrange this through the dealer either - you can get a personal loan from any high street bank, though it’s worth shopping around through a price comparison site to ensure you find the best possible deal.

Can I use a credit card?

You can use a credit card to cover the cost of a vehicle, so long as you have a sufficient credit limit. This might be an attractive idea if you have a card that charges 0% interest on your purchases for a set period, as you can then pay it off in chunks without being whacked with additional interest.

However, it’s worth bearing in mind that not all dealerships accept credit card payments, and those that do may impose payment charges, so it’s worth doing your homework in advance.

How to ensure you don’t pay over the odds

The right car finance package will depend entirely on your circumstances. For some who want to shift cars every couple of years a PCP deal is a smart move, but for others who want complete ownership from the moment they leave the forecourt, a personal loan is a better option.

It’s really important that you sit down in advance and work out what you are looking for from your car finance deal. It’s also a good idea to shop around to see what drivers are being charged for these deals across different dealerships, and through different credit brokers.

When you spot the car that you want, don’t let your desire to get behind the wheel rush you into making a rash decision. Take your time and ensure that you fully understand the package on offer. Only once you are satisfied that you’ve secured a fair deal should you sign on the dotted line.

by John Fitzsimons

John Fitzsimons is a freelance financial journalist who has been writing about money for more than a decade. appearing in the likes of the Sunday Times, the Mirror, the Sun and Forbes.

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